Working Paper 366 Innovation, Efficiency and …1 Innovation, Efficiency and Inclusion: Integration...
Transcript of Working Paper 366 Innovation, Efficiency and …1 Innovation, Efficiency and Inclusion: Integration...
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Working Paper 366
Innovation, Efficiency and Inclusion:
Integration of digital technologies in
the Indian microfinance sector
Saon Ray
Sandeep Paul
Smita Miglani
October 2018
INDIAN COUNCIL FOR RESEARCH ON INTERNATIONAL ECONOMIC RELATIONS
Table of Contents
Abstract ...................................................................................................................................... i
1. Introduction ........................................................................................................................ 1
2. The digital revolution – digital technologies and pathways to development ............... 2
2.1 Innovation ................................................................................................................... 3
2.2 Efficiency..................................................................................................................... 4
2.3 Inclusion ...................................................................................................................... 5
3. The Indian Microfinance Industry ................................................................................... 6
4. Conclusion ........................................................................................................................ 12
References ............................................................................................................................... 13
List of Figure
Figure 1: Development mechanisms of digital technology ............................................... 3
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Abstract
Digital technologies are rapidly making inroads into all realms of human life and the
microfinance sector is one such area. Ongoing innovations in digital technology are
contributing to reshaping its operational models, governance structures, its risk profile,
industry networks and dominant practices. Innovation and integration of digital technology
are both important because of their potential to promote development by spurring innovation,
improving efficiency and increasing inclusion. This paper explores how these mechanisms -
innovation, inclusion and efficiency – have been integral to microfinance operations in the
past, and how innovations in digital technology may be yet another opportunity for
microfinance institutions to promote development. We refer to examples from the Indian
microfinance industry to explore how the digital technology changes are shaping the
microfinance sector.
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Keywords: Digital innovation, Digital technologies, Microfinance
JEL Classification: E 59, F39, G21
Author’s email: [email protected]; [email protected]; [email protected]
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Disclaimer: Opinions and recommendations in the report are exclusively of the author(s) and not of
any other individual or institution including ICRIER. This report has been prepared in good faith on
the basis of information available at the date of publication. All interactions and transactions with
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Innovation, Efficiency and Inclusion:
Integration of digital technologies in the Indian microfinance sector
Saon Ray, Sandeep Paul and Smita Miglani
1. Introduction
The micro finance industry has a long and eventful history. Evolved out of efforts to combat
poverty through capacity-building and women empowerment, micro finance is now a major
component of banking systems in the developing world. Microfinance institutions are
essentially financial intermediaries which made their mark by using innovative approaches to
realize goals that were considered untenable by mainstream banking. These institutions gave
small loans without collateral, to clients from low-income groups predominantly engaged in
income-generating activities in the informal economy (Jayadev, 2016). For long time, it was
believed that the free market could not provide financial services to the poor, effectively and
efficiently. However, pioneers of microfinance such as those behind Bangladesh’s Grameen
Bank demonstrated that it was possible to have a ‘social business’ (Cull, et al. 2009). At the
heart of that success story were innovative lending methods such as the joint liability
approach which mitigated the risk of defaults and ensured repayment. These organizations
were able to provide financial services, most importantly credit, to the poor in a profitable
manner on a large scale. The formal banking system repeatedly failed on these points because
of imperfect information about the borrower's creditworthiness, high transaction costs and
lack of collateral. Microfinance institutions did the unthinkable by ‘banking the unbankable’.
Microfinance has always been seen globally as an important tool for alleviating poverty and
financial development. The immense potential for improving financial access was seen as the
key strength of the tool. The development literature has been very explicit about how
improved access to finance is likely to reduce inequality, promote growth and reduce poverty
(for instance, Demirgüç-Kunt, et al. 2007). It has been pointed out that that microfinance
should not be seen only as an anti-poverty strategy but should be considered as an integral
component of a developing country's broader financial development strategy (Barr, 2005).
According to Barr (2005), this can take place in many ways. In addition to alleviating poverty
and creating livelihoods, microfinance operations can promote market deepening that, in turn,
advances financial development. They could also be a tool for development in the face of
poor governance due to weak formal institutions or inadequate legal and policy environment.
They also accelerate the growth of the banking sector and help the financial market to mature,
especially in developing countries. Finally, they can be part of strategies to promote
domestic financial reforms because they tend to increase competition and bring about
financial liberalization.
The microfinance sector is on the cusp of transformation, worldwide, with the integration of
digital technologies pushing the sector towards fundamental changes of its characteristics and
Acknowledgements: The authors would like to thank Tamal Bandyopadhyay and P. Satish for comments on
an earlier draft of the paper.
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organization. In this paper, we attempt to understand how innovations in digital technology
may help the microfinance sector better fulfill its role in development in the context of India.
The paper is organized as follows: the next section examines the literature on how integrating
digital technology can promote development. We adopt the framework in World Bank (2016)
which identifies the mechanisms through which the developmental process unfolds namely
innovation, inclusion and efficiency. The subsequent sections argue that these three
mechanisms have been integral to microfinance operations in the past and innovations in
digital technology could open up yet another opportunity for microfinance institutions to
promote development through these mechanisms.
2. The digital revolution – digital technologies and pathways to development
Digital technologies are rapidly spreading across the world and are making inroads into all
realms of human life. Digital innovations are creating new channels of engagement,
expanding opportunities and increasing efficiency for individuals, businesses and
governments. The microfinance industry across the world is also fast adapting itself to
technology changes in the financial sector. While digitization of back-end operations has
been underway in the MFI industry for a long time now, there is increased adoption of
technology in other aspects of operation also. There is also increased collaboration with
fintech companies to better embrace technology. Migration of BC Finance (Myanmar) to a
private block chain with the help of Japanese technology firms, Infoteria and Tech Bureau;
MFIs in Philippines using an open Cloud-based Computing Systems (CBS) platform through
open Application Program Interface (APIs),1 and National Payments Corporation of India
(NPCI) digitizing MFI transactions using its Aadhar Payment Bridge System (ABPS), are
some examples of technology integration (PwC, 2017).
Increased connectivity and technological innovations allow a range of developmental
benefits, digital dividends (World Bank, 2016), which could boost growth, expand
opportunities and improve service delivery. As seen in the following diagram Figure 1,
digital technologies promote development through inclusion, innovation and efficiency. As
digital technologies expand, reduction of information asymmetries increases inclusion. The
improved information flow between different parties facilitates more transactions at reduced
cost and risk. As the existing activities become cheaper and quicker, there is also an
improvement in efficiency. This happens because growth in information and communication
technology allows reduction of existing factors of production and augments the productivity
of factors that are not substituted. Most importantly, it spurs innovation as the growth in
technology improves scales of economy and reduces marginal costs substantially.
1 https://www.pwc.in/assets/pdfs/publications/2017/microfinance-in-asia-a-mosaic-future-outlook.pdf
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Figure 1: Development mechanisms of digital technology
Source: Adopted from World Bank (2016)
2.1 Innovation
It is important to understand the ongoing changes in the microfinance sector from the angle
of innovation, especially in developing countries. As an entrepreneurial activity, the sector
has always been a hotbed of innovation. Morduch (1999) comments that, “the promise of
microfinance was founded on innovation: new management structures, new contracts, and
new attitudes.” Mersland and Strom (2012) identify five categories of innovation in
microfinance: targeting of poor customers, targeting of women, new lending technologies,
new organizational solutions and new sources of funding.
All the above-mentioned changes were largely new to the existing banking sector and gave
rise to a new product market altogether (Mersland and Strom 2012). Microfinance provides a
solution to classical problems of asymmetrical information faced by the banking sector.
Before emergence of microfinance, poor customers were served by money lenders or state-
owned banks in a situation that was far from an efficient social equilibrium. State-run banks
depended heavily on subsidies to cater to this section of customers but had low penetration
and repayment rates. Lack of collateral was a large drawback and excluded the bulk of poor.
The programs cost the government dearly as little in the way of savings was collected, little
credit was delivered, and default rates accelerated (Morduch, 1999). The moneylender loans
were more easily available but were nothing short of exploitative and caused huge negative
externalities to the society.
By contrast microfinance loans targeted high-risk borrowers, especially women. The group
lending methodology negated the need for collateral and solved the problems of screening,
repayment and auditing. The loans were small and were given for income-generation
activities. MFIs also used dynamic incentives, regular repayment schedules, and collateral
substitutes to help maintain high repayment rates (Morduch, 1999). The targeting of women
was another innovative approach, away from traditional male-centric banking. The
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advantages of women-centric businesses were many: from a social perspective, it promoted
gender equality, poverty reduction and provided more positive externalities for society and
economy. From the business perspective it reduced moral hazard problems, heightened
dynamic incentives (Morduch, 1999) and better repayment rates (Mersland and Strom, 2012).
Much has changed in the microfinance industry over the last two decades: microfinance
institutions are no longer exclusive, with the participation of commercial banks increasing.
The poverty-alleviation practitioners who pioneered modern microfinance have been
marginalised by commercial financial institutions (Kent and Dakin, 2013). The sector also
saw increasing convergence in regulations in the financial sector. Even though commercial
microfinance institutions were able to face this challenge by reorienting their business
models, the original developmental vision has taken a step back. With its unique selling point
in question, the industry is under pressure to innovate.
While the basic premise of small non-collateralized loans remains, the sector is experiencing
what can be termed a ‘technological transition’ (Geels 2002) - implying not only
technological changes, but also changes in user practices, regulation, industrial networks,
infrastructure, and symbolic meaning (Geels 2002). The microfinance sector will also have to
follow the current trend of integration of digital technology into mainstream financial
services, even though they differ. Unlike the financial services sector where there are
innovations in both, product and process, the MFI sector is witnessing largely a process
innovation (Tidd et al., 2005) with significant improvements in the production or delivery
method. Evidently, these changes are not a single event of technical advance but are part of
an ongoing cumulative technological advance (Nelson and Winter, 1982) characterized by
continuous evolution where new evolves out of old.
2.2 Efficiency
The biggest roadblock to efficiency in any market is high transaction costs and inefficient use
of factors of production. As discussed earlier the financial sector had failed to provide
banking services to a large number of people: inefficiencies made transactions in the markets
expensive, distorted prices and excluded potential participants. Microfinance lowered
transaction costs and made more efficient use of resources employed. These efficiency gains
were not limited to the financial sector but included consumers and the larger economy as
well. Increased credit availability meant increased economic opportunities and reduced
deprivations which could back development.
With commercialization and increased competition, the efficiency in operations which used
to characterize microfinance activities came under threat; imposition of rate caps etc., caused
a decline in margins in many countries. The Indian case, which we discuss in a later section,
is an example for how inefficient operations of even a few in the face of commercialization
could create a crisis in the entire sector. Also, as Kent and Dakin (2013) point out, the norms
for behavior in microfinance have become less distinguishable from mainstream commercial
banking across the world. They have to adhere to standards similar to those in the banking
industry and yet deliver in their traditional markets. The fact that the cost of funds to
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microfinance institutions is much larger compared to their banking competitors complicates it
further and warrants significant improvement in efficiency in all realms of operation.
Technology has potential to aid the industry through improvements in efficiency: there is
potential to lower transaction costs and increase the productivity of existing factors of
production. It has been reported that MFIs handling small transactions for dispersed
populations tend to have operating costs in the range of 12-15%, while the same for banks is
less than 5% (Moro Visconti and Quirci, 2014). In the case of MFIs, operating expenses are
the most important cost component. Kneiding and Ignacio (2009) based on a sample of 1,003
MFIs in 84 countries find that the three main drivers of operating expense ratio (OER) are
relative loan sizes, ages and scale. As per this study these variables impact efficiency in three
ways. Firstly, higher numbers of loans may drive scale economies; secondly, higher average
loan sizes may improve the cost structure and finally, more knowledge about customers may
streamline processes.
2.3 Inclusion
The microfinance sector pioneered financial inclusion with its extension of financial services
to the unbanked. The growth of sector was rapid across the world especially in neglected
rural areas and among women, both novelties in pro-poor banking initiatives at the time
(Mersland and Strom 2012). Microfinance operations, recognized importance of women's
participation in financial services and the attendant social benefits. Owing to their
participatory nature microfinance operations also successfully complemented the formal
banking system and brought more people into its fold. The extensive networks of
microfinance organization and unique strategies to cut cost and risk aided the banks in
deepening their presence.
As the competition in the sector grew, the social aspect began diminishing as microfinance
institutions increasingly targeted clients who were easier to access (Kent and Dakin, 2013),
shifting new additions to the consumer pool to the better-off among the poor, or from urban
areas, or those who were involved in businesses with rapid turnover, such as retail (Kent and
Dakin, 2013). Chasmer (2009) terms this tendency of shifting business to wealthy clients as
‘mission drift’. While commercialization and increasing competition may be the most cited
reasons, this could also have arisen from the necessity to conform to stringent regulatory
requirements such as capital adequacy ratios (Chasmer 2009). It is at this juncture that digital
technologies become important, as they provide a means to reach out to the margins and
adopt a broader, inclusive business model.
The spread of digital technology will improve inclusion in both, new and existing markets.
The World Bank (2016) argues that this happens because some transactions did not exist
previously. This could be either because parties of potentially beneficial transactions did not
know each other or when one had more information than the other. Digital technologies can
solve these problems because they provide access to information and enable searches. The
problems in above mentioned cases were not as much related to cost as they were to trust and
transparency. Technology innovations make monitoring and sharing of information much
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easier. User-specific information allows the firms to use newer risk mitigation strategies and
provide more individualized services. The increased use of credit bureau data in the Indian
market is a good example. The MFIs are actively availing the service of credit bureaus and
also contribute to them. Integration with the credit bureau system is highly beneficial to the
consumer also, as it considerably eases future engagements with mainstream financial actors.
Advances in technology also allow adoption of a broader view of financial inclusion, taking it
beyond mere provision of financial services to the unbanked. Financial inclusion does not
mean just access to financial services, but also ensuring continuous and efficient use of these
services, which depends on both demand and supply (Demirgüç-Kunt, et al. 2007).
Technology innovations have immense potential to address the under banked who might be
voluntarily or involuntarily excluded from the system. These innovations differ from others
in that they can be more rapidly adopted, and are pioneered largely by new and small players.
MFIs can easily collaborate with the new crop of players to usher in new models of operation
and service delivery.
3. The Indian Microfinance Industry
The origin of India's microfinance industry can be traced back to community development
programmes and the emergence of self-help groups (SHGs). While these movements
provided a foundation for microfinance activities, the biggest fillip came through NABARD's
SHG-bank linkage program (SHG-BLP) in which NGOs were encouraged to promote and
groom SHGs who would park their savings with existing banks and within the existing legal
framework (Karmakar, 2008). Micro finance institutions are now an important component of
the Indian banking sector. These institutions which came into existence around the same time
as SHG-BLP and have been constantly evolving. Inspired by the success of the Grameen
Bank in Bangladesh, there was a flurry of activity in the sector, with a large number of
organizations undertaking financial intermediations for social good (NABARD, 2016). Most
of these were NGOs who borrowed in bulk from various sources. While most of them entered
as not-for-profit entities, over time many of them evolved into for-profit entities and non-
banking financial companies (NBFCs). Aided by a favorable policy environment and huge
capital inflows, the sector grew rapidly especially in the second half of the 2000s. The sector
has grown since then (despite intermittent crises) and now there are a considerable number of
NBFCs, commercial banks, as also not-for-profit trusts, societies and NGOs. The MFI sector
is dominated by NBFC-MFIs, which account for 79% of the total loan portfolio. Nearly 82%
of the portfolio is held by MFIs with a portfolio size above Rs.500 crore (Sa-Dhan, 2017).
Evidently, the sector is dominated by large for-profit commercial entities with marginalized
presence of others.
As mentioned earlier, as the microfinance industry grew and evolved in India, it faced similar
challenges as it did in other countries, with respect to the role in development. Where
efficiency is concerned, the biggest crisis surfaced in Andhra Pradesh in 2010 (Priyadarshee
and Ghalib, 2011; Jariwala and Mehta, 2015) with reports emerging of coercive recoveries
and suicides by borrowers. Andhra Pradesh was the national leader in terms of loan portfolio
with a total loan outstanding of about Rs. 5,210.8 crore. In 2010, 56% of the total client
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outreach of MFI was from the southern region and Andhra Pradesh alone accounted for
nearly 42% of the total client outreach within the region. Though opinions differ as to the
exact causes of crisis, there is broad agreement that the genesis lay in some MFIs flouting the
fair-lending practices in their bid to build portfolios (Kaur and Dey, 2013), leading to over-
indebtedness and distress in many pockets. The issue culminated in enactment of the Andhra
Pradesh Microfinance Institutions (Regulation of Moneylending) Act, 2010. Faced with
tough regulations and a negative environment, the MFI activities in the state crumbled,
leading the sector into a crisis with a huge impact: defaults and operating costs soared making
the MFI activity unviable and unprofitable. This in turn affected the asset quality of MFI
players as write-offs increased from 0.6% in FY09 to approximately9% in FY11 (Jariwala
and Mehta, 2015). The reluctance of banks to lend to companies worsened issues (Kaur and
Dey, 2013) because of which corporate debt restructuring (CDR) bailout packages had to be
rolled out to major MFI players operating in Andhra Pradesh (Jariwala and Mehta, 2015).
The crisis was not restricted to Andhra and had a nationwide impact; for example, costs per
borrower for MFI’s outside Andhra Pradesh increased by 60%. The crisis of 2010 led to
several regulatory reforms and improvements in the operational practices of microfinance
companies in India.
Following the recommendations of the Malegam Committee, the Reserve Bank of India came
up with a detailed set of guidelines for the industry and created a new non-banking category
for MFIs known as NBFC-MFIs, which has drastically changed the industry's character.
Despite its growth, questions remain about the nature of growth and financial inclusion. A
quick analysis reveals that the industry is heavily skewed towards large NBFC-MFIs with
others lagging behind. As per Sa-Dhan (2017), the total debt funds received by the sector
during 2016-17 was close to Rs. 26236 crores excluding SFBs. Out of this 95% went to
NBFC-MFIs. In terms of size, the majority of funds (84%) went to large MFIs with a
portfolio size above Rs. 500 crores. The industry is also experiencing an escalation in cost of
funds: in 2015-16, the cost of funds for MFIs in India ranged from 11% to 15% for different
institutions with a median of 13.3% (for all segments) (Sa-Dhan, 2016 b).2 Data from
microfinance institutions network (MFIN), the industry body of NBFC-MFIs shows that the
average cost of funds has consistently been much smaller for large NBFC-MFIs when
compared to midsized or small size institutions (MFIN, various years).
On the inclusion front, the industry had witnessed a brief stagnation in client outreach,
especially in 2012 and 2013, but has been growing since then. An important feature of this
growth is that the sector has shed its image of being rural phenomenon. The rapid increase in
share of urban clientele is certainly noticeable. The share of rural clientele, which was 69%,
came down to 33% in 2015. This certainly hints at the possibility of the mission drift
(Chasmer 2009) discussed above.
2 Large MFIs refers to institutions with a gross loan portfolio (GLP) more than Rs. 500 crore and medium
refers to institution with a GLP of Rs. 100-500 crore and small refers to those of GLP less than 100
Rs.crore.
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Digital technologies and microfinance
It is at this juncture, that the development in digital technology assumes importance:
following prevailing trends in the financial sector, microfinance companies are also rapidly
adopting digital technology. The need to integrate technology with microfinance operations
has been a major policy agenda since the late 2000s. Prior to this, the institutional support
programs for MFIs were largely directed at demand-side issues and human resources
capacity-building. To understand how technology as a theme permeated into the microfinance
sector, past issues of Status of Microfinance3 reports, Bharat Microfinance reports and
Inclusive finance reports were analyzed. Technological innovations were found to be a
consistent theme in capacity-building programs from the 2003-04 onwards. The aim was to
adopt innovations that support outreach and sustainability. This period saw various pilot
projects to promote technological integration such as Computer Munshi,4 e-Grama and
branch automation.5 While e-Grama was a program for setting up village information centers,
the other two aimed at improving the book-keeping and efficiency of field workers.
Technology was seen as an instrument or means to improve efficiency, particularly of back-
end operations. The clear incentive in terms of efficiency gains was attractive and there was
widespread adoption of Management Information Systems (MIS), Automatic Teller
Machines (ATMs), Interactive Voice Response (IVR) systems, etc. Specialized software for
loan management, accounting, human resources management and monitoring were other
technology-based additions introduced during this period. Delfix Nano, Bijli, Ganaseva,
Efimo are some examples of software which were adopted by MFIs (Srinivas and Mahal,
2017).
Official policy documents reflect this approach. The Rangarajan Committee Report (2008) on
financial inclusion which states the need to leverage technology-based solutions saw it
primarily as a tool to reduce transaction costs. The Committee noted that operating costs of
small credits were high and varied widely across institutions depending on operating models
and cost structure. The recommendations of the Committee also led to the setting up of a
Financial Inclusion Technology Fund (FITF) to enhance investment in Information and
Communication Technology (ICT).
An important push for technological adoption for many MFIs came via the banking
correspondent (BC) partnerships with commercial banks. A technology-based model aimed
to increased access of people in remote areas to formal financial institutions (Sa-Dhan, 2017),
BC activities have been part of Indian financial services industry since 2006. In this model,
the banks are allowed to outsource financial services through business correspondents and
business facilitators. MFIs, which had extensive rural networks soon emerged as preferred
allies leading to the emergence of ‘partnership models’ (Nair and Tankha, 2014). The
partnership between ICICI Bank and Cashpor with FINO as technology provider is an
3 An annual publication by NABARD on the sectoral development of microfinance operations in India
4 Computer Munshi program involved training of skilled local youth in computer operations and specially
designed software to maintain SHG accounts. 5 Branch automation in this context referred to installation of personal computers in branches, information
kiosks and provision of processor and memory cards to self-help groups (NABARD, various years).
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example of such a model (Nair and Tankha, 2014). The model, mostly promoted by private
banks, flourished until the Andhra Pradesh crisis. The BC business thereafter was largely led
by corporate BCs (mostly technology service providers) but could not be sustained. With the
emergence of NBFC-MFIs, partnership models were eventually revived with more
opportunities and increased role for MFIs. Currently, the BC portfolio is one of the most
important for MFIs constituting 21% of the total portfolio and 69% of the managed portfolio
(Sa-Dhan, 2018a). The BC model also, in many ways, pushed the switch of MFIs to digital as
the partnership emerged as a profitable business domain with good returns, especially for the
smaller MFIs. As banks had already moved ahead with the use of technology in operations,
the BC partnership provided the incentive, motivation and much needed familiarization for
MFIs to migrate to newer technology. General Packet Radio Service (GPRS) enabled mobile-
based online applications, portable printing devices synchronized with mobile handsets, real-
time data transfer to servers, biometric smart cards were a few technology additions whose
popularity can be ascribed to the BC role of MFIs and their engagement with banks (Sa-
Dhan, 2016). While, on the one hand the BC model fast-tracked adoption of technology-led
models in microfinance institutions, it also familiarized the clientele, most importantly rural
population, with digital financial services.
A major shift in the approach towards adoption of technology in the MFI sector, however,
came only when there was large scale penetration of mobile-based technology at various
levels of operation. The larger penetration of mobile technology, internet and mobile
banking aided the process, making it clear that technology was the key driver for promoting
financial inclusion. In this phase, attention focused on the impact on inclusion, of technology.
It was also the period of recovery for the MFI industry as the institutions were actively
looking for alternative operational models to improve their reach. This allowed digitization of
front-end activities through real-time data entry, geo-tagging, financial literacy videos to
educate clients, etc. An early example of mobile technology adoption was that by Sonata
Finance Pvt. Ltd. (Sa-Dhan, 2015). One of the first few to use mobile technology in loan
approvals and disbursal, the large scale adoption of mobile technology brought in multiple
benefits as it allowed the company to track transactions on a real time basis, fetch real-time
reports, digitize physical records and improve transparency and process efficiencies (Sa-
Dhan, 2015).
Recently a series of innovations is rapidly changing processes within the industry. An
example would be increased adoption of cash-lite models for disbursements and repayments
by MFIs of all sizes despite concerns of high upfront costs. While these are partly prompted
by ongoing innovations in the financial services sector, there are also some other, equally
important drivers. The State is a major actor as there is an ongoing policy push for
digitization in the country. The Indian Government has pushed digital transformation in the
country through initiatives such as Digital India, Digidhan mission, Jan Dhan, JAM trinity.
The development of a neutral and open payment ecosystem in the country has proved to be
beneficial to the MFI sector. The increased adoption of Immediate Payment Services (IMPS),
Unified Payment Interface (UPI) and National Unified USSD Platform (NUUP) is enabling
MFIs to provide multiple products and reap the benefits of digital finance. A visible example
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of transition to digital finance is the increasing proportion of cashless disbursement in total
loan disbursement. Sa-Dhan (2018 b) reports that during Q4 of the financial year 2017-18,
45% of the total amount disbursed was cashless. The cashless mode is gaining traction so
much that, there have been reports of institutions completely shifting to through cashless
mode for loan disbursal and other digital initiatives such as E-KYC (Sa-Dhan, 2017).6
Technological integration is also taking place in the bank-linked SHG sector which tends to
lag behind MFI institutions in this respect. The EShakti7 programme of NABARD which
attempts to attempts to promote digitization among self-help groups is a noteworthy
initiative: the programme aims to address issues of quality of book-keeping, multiple
membership of SHG members, credit history of members, etc. Here, technology promotes
access to affordable credit by removing information asymmetries holding SHGs back from
becoming part of the larger banking system.
Similarly, MFIs are now entering into collaboration with fintech companies. PwC (2017)
reports that there are multiple examples of collaboration of MFIs and fintech companies in
India for customer on-boarding, credit assessment, loan disbursal and collections. The
Entrepreneurial Finance LabEFL, a psychometric credit assessment company providing credit
assessment services to Janalakshmi Financial Services (an MFI), partnership between Oxigen
Services and Sonata Finance Limited (an MFI) to deliver mobile financial services and
education to the latter’s clients, Artoo, a technological company helping Ujjivan (an MFI, and
now a Small Finance Bank) to on-boarding customers are some of the examples of such
collaborations8 (PwC, 2017). These collaborations have not only been innovative but also
added to the efficiency of operations and help achieve the objective of the financial inclusion
agenda. A major characteristic of these innovative partnerships is that along with improving
the current products, they also make a wide array of new financial services accessible to the
previously excluded. The growth in credit plus activities (Sa-Dhan, 2107) in India such as
micro-insurance and micro-pension are some examples. As of 2017, MFIs had enrolled 14.68
lakh clients for health products and about 51.1 lakh clients for non-health products (Sa-Dhan,
2107).
As discussed earlier, rapid integration of digital technology is causing a process innovation in
the industry: field workers may not be displaced completely but their relevance would clearly
diminish. The growth in cashless operations and digital payments will curtail the risks of
cash-based operations and improve operational efficiency and cost savings. The service
provision and risk management would no longer solely depend on physical outreach as many
insights can be drawn from the digital data produced in the course of operations. MFIN
(2017) reports that organizations which adopted ‘cash-lite’ models reported reduction in
turnaround time, reduction of risk of errors and fraud in disbursement and repayment, and
reduction of reconciliation tasks owing to data shared by technology service providers. Also,
6 MFIN (2018) reports that of the 42 member NBFC-MFIs of the association, 25 institutions have reported
100% cash-less disbursements in the first quarter of financial year 2018-19. The total loan amount in
cashless by all member NBFC-MFIs of MFIN in Q1 FY 18-19 amounted to Rs 11,404 crore which was
disbursed through 42 lakh loan accounts (MFIN, 2018). 7 https://www.nabard.org/auth/writereaddata/tender/1907183104SMFI%202017-18.pdf
8 https://www.pwc.in/assets/pdfs/publications/2017/microfinance-in-asia-a-mosaic-future-outlook.pdf
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there has been considerable change in the engagement strategy of institutions as tools for
financial literacy improved significantly. Technology-driven change is taking place not only
on digital field applications to on-board customers or improve lead management activities
(PwC, 2016) but also through automation and increased reliance on analytics. The ongoing
integration of credit bureau data, E-KYC, Aadhar-enabled payments, adoption of self-service
options, e-payments, are some other elements of the ongoing transition in the sector. The
rapid spread of enabling architecture such as Aadhar and E-KYC will bring huge gains in
operating expenses but also might change the drivers of operating expense reduction. A
labour-intensive industry, MFI operations also have high costs associated with workforce and
their operations. In India, 60% of the total staff is field staff, and the increased use of
technology channels such as ATMs, POS machines, mobile banking, etc., can bring about
gains in efficiency.
Challenges
While innovation and integration in digital technology has benefits, there are also challenges,
some of which are already emerging. The gains from technological integration are far from
homogeneous, with mainly the large companies making noticeable efficiency gains. For
example, the number of active borrowers served by a single credit officer is more for bigger
institutions when compared to their smaller counterparts (Sa-Dhan, 2017). This is because
MFIs with large scales of operation were able to put in place systems and processes that
significantly reduced the time that credit officers spent with the client (Sa-Dhan, 2017), while
the small ones could not do the same. This situation can change if there is larger permeation
of cost-effective technological innovations.
Another issue that is plaguing the sector is coping with reducing the ‘human touch’ element
in microfinance operations that distinguished it from the mainstream banking sector, as
operations gets increasingly digital. As the sector dealt almost exclusively with small and
uncollateralized credit to clients from low-income groups for income-generation activities in
the informal economy, it always had the human touch, was, by nature participatory and
bottom-up. Though there were only three or four broad models of operation, the way in
which each institution approached these models often varied in terms of governance
structure, channel and method of delivery, accountability framework and product. The
success of the organization depended on how well it understood the clientele and geography
in which it is operated. It has been suggested that performance of microcredit organizations
not only relies on the macroeconomic and formal institutional environment, but is also
closely related to social beliefs, particularly trust and norms of cooperation (Berggren and
Burzynska, 2014). Networks and trust were important to microfinance operations at multiple
levels of interaction and were crucial in defining the outcomes. Most importantly, this web of
networks built over trust and peer pressure was critical to the efficiency of the firms'
operation. Another crucial cog in this ecosystem were field agents and loans officers who
built and maintained vital client interfaces that ensured institutional survival (Siwale and
Ritchie, 2012). In their primary role as facilitators, field workers ensured extension of micro
financial services in an area by helping overcome clients’ reluctance to participate, helped
12
loan officers reduce the probability of delinquency and ensured high-quality services (Siwale
and Ritchie, 2012) (Fisher and Sriram 2002). The increased adoption of digital technologies
threatens the very fundamentals of the industry. How the industry will cope with the changes
remains to be seen.
The sector is also facing increased competition from technology-driven fintech companies
and universal banks as there is an increasing overlap of markets. Fintech lenders such as
Capital Float, Neo Growth Credit Limited, Indifi Technologies Pvt Ltd. are also providing
micro credit to under-served and un-served markets (PwC, 2017). The increased
collaboration between commercial banks and fintech startups also intensifies the competition.
These new partnerships allow banks to overcome the earlier drawbacks of cost and
informational asymmetry to better target previously left out clients. Though the indirect
competition is not intense at the moment, digital innovations are fast blurring the boundaries
within and outside the market.
4. Conclusion
The microfinance sector is on the cusp of a transformation, worldwide. The integration of
digital technologies is pushing the sector to a transformation which might affect its
fundamental characteristics and organizational processes. While the integration of technology
can promote development through innovation, efficiency and inclusion, the path ahead for
the sector may not be smooth. How the innovations will pan out and impact the sector
warrants more detailed enquiry. While the quantum of benefits is unclear, it can be said with
certainty that technological advancement alone will not bolster development. What is equally
important is the nature of competition and challenges. There is possibility of a digital divide
(Word Bank, 2016) as bigger firms are in a better position to integrate technology faster and
more efficiently. Inequality in access and barriers to productive use are also stumbling blocks
in realizing efficiency gains put forth by technologies. Such problems are more pertinent in
case of technologies whose gains are a consequence of networks effects that arise when a
large number of people use it. The skills and logistics already in place are thus very crucial.
It has to be remembered that the realization of developmental benefits is far from automatic
and depends on the country-specific business climate, regulatory framework and skill level of
labour force.
13
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